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A Course Material on
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MrS. THANGAMANI.V
ASSISTANT PROFESSOR
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MG245 ENGINEERING ECONOMICS AND FINANCIAL ACCOUNTING
QUALITY CERTIFICATE
Being prepared by me and it meets the knowledge requirement of the university curriculum.
Name:
Mrs.V.Thangamani
This is to certify that the course material being prepared by Mrs.V.Thangamani is of adequate quality. He has
referred more than five books amount them minimum one is from aborad author.
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CONTENTS
CHAPTER TOPICS PAGE NO
INTRODUCTION
1.1 Introduction of Managerial Economics
1.2 Nature and scope of managerial economics
1 1.3 Relationship with other disciplines
1.4 Firms and its Types
1.5 Objectives and goals
1.6 Managerial decisions and its analysis
DEMAND AND SUPPLY ANALYSIS
Demand
Types of demand
Determinants of demand
Demand function
2 Demand elasticity
Demand forecasting
Supply
Determinants of supply
Supply function
Supply elasticity
PRODUCTION AND COST ANALYSIS
Production function
3 Returns to scale
Production optimization
Least cost input
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UNIT-I
INTRODUCTION
Managerial Economics Relationship with other disciplines Firms: - Types, Objective and Goals
Managerial economics is economics applied in decision making. It is the branch of economics which
serves as a link between abstract theory and managerial practice.
It is based on the economic analysis for identifying problems,organizing information and evaluating
alternatives.
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Managerial economics is the integration of economic theory with business practice for the purpose of
facilitating decision making and forwardplanning by the management.
1. It is microeconomic in character as it concentrate only on the study of the firm not on the working of the
economy
2. It takes help from the macroeconomics to understand the environment in which the firm operates
3. It is normative rather than positive i.e., it gives answer for the question what ought to be than what is ,was.
6. Knowledge of managerial economics helps in making wise choices.i.e., choices among scarcity of
resources.
4. It helps in providing most of the concepts that are needed for the analysis of business problems,the
concepts such as elasticity of demand ,fixed, variable cost, SR and LR costs, opportunity costs,NPV etc.,
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Economics and Managerial economics both are facing identical problems,i.e., problem of scarcity and
resource allocation. Since labour and capital are always limited it must find way for effective utilizing of these
resources.
Both operations research and managerial economics are concerned with taking effective
decisions, managerial economics is a fundamental academic subject which seeks to understand and to analyse
the problems of business decision making while OR is an activity carried out by functional specialist within the
firm to help the manager to do his job of solving decision problems.
OR models like queuing,linear programming etc.., are widely used in managerial economics
Model building, economic models are more general and confined to broad economic decision
making
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conceptual but also metrical.Its metrical property is used to estimate and predict the relevant economic
factors for decision making and forward planning
Statistics is widely used in managerial economics. It is mainly needed for a correct judgement and
decision making
The theory of decision making is relatively a new subject that has significance for managerial
economics. Much of economic theory is based on the single goal MAXIMISATION OF PROFIT, but theory of
decision making recognizes the multiplicity of goals and the pervasiveness of uncertainity
The task of organizing and processing information and then making an intelligent decision based
upon two general forms
Production scheduling
Demand forecasting
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Market research
Investment appraisal
Advice on trade
Definition of firm
A firm is the small business unit involved in producing the profit Business (company, enterprise or firm) is a
legally recognized organization designed to provide goods or services, or both, to consumers, businesses and
governmental entities.[1] Businesses are predominant in capitalist economies. Most businesses are privately
owned. A business is typically formed to earn profit that will increase the wealth of its owners and grow the
business itself. The owners and operators of a business have as one of their main objectives the receipt or
generation of a financial return in exchange for work and acceptance of risk. Notable exceptions include
cooperative enterprises and state-owned enterprises. Businesses can also be formed not-for-profit or be state-
owned.
Types of firms
Sole proprietorship:
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A sole proprietorship is a business owned by one person. The owner may operate on his or her own or may
employ others. The owner of the business has personal liability of the debts incurred by the business.
Partnership:
A partnership is a form of business in which two or more people operate for the common goal which is
often making profit. In most forms of partnerships, each partner has personal liability of the debts incurred by the
business. There are three typical classifications of partnerships: general partnerships, limited partnerships, and
limited liability partnerships.
Corporation:
A corporation is either a limited or unlimited liability entity that has a separate legal personality from its
members. A corporation can be organized for-profit or not-for-profit. A corporation is owned by multiple
shareholders and is overseen by a board of directors, which hires the business's managerial staff. In
addition to privately owned corporate models, there are state-owned corporate models.
Cooperative:
Often referred to as a "co-op", a cooperative is a limited liability entity that can organize for-profit or not-for-
profit. A cooperative differs from a corporation in that it has members, as opposed to shareholders, who share
decision-making authority. Cooperatives are typically classified as either consumer cooperatives or worker
cooperatives. Cooperatives are fundamental to the ideology of economic democracy.
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GOALS OF FIRMS:
Conventional theory of firm assumes profit maximization is the sole objective of business firms. But
recent researches on this issue reveal that the objectives the firms pursue are more than one. Some
important objectives, other than profit maximization are:
Profit means different things to different people. To an accountant Profit means the excess of revenue
over all paid out costs including both manufacturing and overhead expenses. For all practical purpose,
profit or business income means profit in accounting sense plus non-allowable expenses.
Economists concept of profit is of Pure Profit called economic profit or Just profit. Pure profit is a
return over and above opportunity cost, i. e. the income that a businessman might expect from the second best
alternatives use of his resources.
The reason behind sales revenue maximisation objectives is the Dichotomy between ownership & management in
large business corporations. This Dichotomy gives managers an opportunity to set their goal other than profits
maximisation goal, which most-owner businessman pursue. Given the opportunity, managers choose to maximize
their own utility function. The most plausible factor in managers utility functions is maximisation of the sales
revenue.
The factors, which explain the pursuance of this goal by the managers are following:.
First: Salary and others earnings of managers are more closely related to sales revenue than to profits Second:
Banks and financial corporations look at sales revenue while financing the corporation. Third: Trend in sales
revenue is a readily available indicator of the performance of the firm.
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Managers maximize firms balance growth rate subject to managerial & financial constrains balance
growth rate defined as:
G = GD GC
Where GD = Growth rate of demand of firms product & GC= growth rate of capital supply of capital to the
firm.
In simple words, A firm growth rate is balanced when demand for its product & supply of capital to the firm
increase at the same time.
The manager seek to maximize their own utility function subject to the minimum level of profit. Managers
utility function is express as:
U= f(S, M, ID)
ID = Discretionary Investments
The utility functions which manager seek to maximize include both quantifiable variables like salary and slack
earnings; non- quantifiable variables such as prestige, power, status, Job security professional excellence etc.
According to some economist, the primary goal of the firm is long run survival. Some other economists have
suggested that attainment & retention of constant market share is an additional objective of the firms. the firm
may seek to maximize their profit in the long run through it is not certain.
Entry-prevention and risk-avoidance, yet another alternative objectives of the firms suggested by some economists
is to prevent entry-prevention can be:
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The Managerial
Decision-Making Process
Process components are decision-making functions.
Decision-making functions are highly interrelated and interdependent.
The process is highly dynamic with several subprocesses.
The process can accommodate several concurrent Category II decisions.
Decision-Making Function No. 1
Setting Managerial Objectives:
Objectives constitute the foundation for rational decision making.
Objectives are the ends for the means of managerial decision making.
Attainment of the objective is the ultimate measure of decision success.
Decision-Making Function No. 2
Searching for Alternatives:
The limitations of time and money
The declining value of additional information
The rising cost of additional information
Abort the search in the zone of cost effectiveness
Decision-Making Function No. 3
Comparing and Evaluating Alternatives:
Alternatives result from the search.
There are usually three to five alternatives.
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The decision analysis (DA) cycle is the top-level procedure for carrying out a decision analysis. The traditional
cycle consists of four phases:
Basis Development
Determinisitic Sensitivity Analysis
Probabilistic Analysis
Basis Appraisal.
Decision theory in economics, psychology, philosophy, mathematics, and statistics is concerned with identifying
the values, uncertainties and other issues relevant in a given decision, its rationality, and the resulting optimal
decision. It is very closely related to the field of game theory.
UNIT II
1.1 DEMAND
Definition of demand
The amount of a particular economic good or service that a consumer or group of consumers will want to purchase
at a given price.
The demand curve is usually downward sloping, since consumers will want to buy more as price decreases.
Demand for a good or service is determined by many different factors other than price, such as the price of
substitute goods and complementary goods. In extreme cases, demand may be completely unrelated to price, or
nearly infinite at a given price.
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Along with supply, demand is one of the two key determinants of the market price.
Meaning of Demand
Demand:The term 'demand' is defined as the desire for a commodity which is backed by willingness to buy and
ability to pay for it.
The law of demand states that, if all other factors remain equal, the higher the price of a good, the less
people will demand that good.
In other words, the higher the price, the lower the quantity demanded. The amount of a good that buyers purchase
at a higher price is less because as the price of a good goes up, so does the opportunity cost of buying that good.
As a result, people will naturally avoid buying a product that will force them to forgo the consumption of
something else they value more. The chart below shows that the curve is a downward slope.
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Short run demand refers to demand with its immediate reaction to price changes and income
fluctuations. Long run demand is that which will ultimately exist as a result of the changes in pricing,
promotion or product improvement after market adjustment with sufficient time.
7.Joint demand and Composite demand:
When two goods are demanded in conjunction with one another at the same time to satisfy a single
want, it is called as joint or complementary demand. (example: demand for petrol and two wheelers) A
composite demand is one in which a good is wanted for several different uses. ( example: demand for iron rods
for various purposes)
8.Price demand, income demand and cross demand:
Demand for commodities by the consumers at alternative prices are called as price demand. Quantity
demanded by the consumers at alternative levels of income is income demand. Cross demand refers to the
quantity demanded of commodity X at a price of a related commodity Y which may be a substitute or
complementary to X.
i. General factors
The consumer will buy more of a commodity when its price declines and vice versa,because it
increases his purchasing power. He can therefore buy more of it.Price and the Demand vary inversely.
The consumer will buy more of a commodity when his income increases and viceVersa.
Both demand and income of the consumer move in the same direction.It may be reverse for inferior goods
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here demand will increase with decrease in the income and vice-versa.
When a change in the price of one commodity influences the demand of the other commodity and
so the commodities are interrelated. These related commodities are of two types: substitutes and
complements.
When the price of one commodity and the quantity demanded of other commodity are move is
same direction, it is called as substitutes
When the price of one commodity and the quantity demanded of other commodity are move is
opposite direction, it is called as complementary
If the consumer taste and preferences are favour of a commodity results in greater demand,
And if it against the commodity it results in smaller demand for the commodity.
In case the consumer expects a higher income in future ,he spends more at present and
thereby the demand for the good increases and vice versa.
Similarly if the consumer expects future prices of the good to increase he would rather like
to buy the commodity now more than on later, This will increase the demand for the commodity.
Demand function -- a behavioral relationship between quantity consumed and a person's maximum willingness
to pay for incremental increases in quantity. It is usually an inverse relationship where at higher (lower) prices,
less (more) quantity is consumed. Other factors which influence willingness-to-pay are income, tastes and
preferences, and price of substitutes
Where
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A = advertising
U= all those determinants that are not covered in the list determinants
P = population
Elasticity is the ratio of the percent change in one variable to the percent change in another variable. It is a tool for
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measuring the responsiveness of a function to changes in parameters in a unit-less way. Frequently used elasticities
include price elasticity of demand, price elasticity of supply, income elasticity of demand, elasticity of substitution
between factors of production and elasticity of intertemporal substitution
Price elasticity of demand measures the percentage change in quantity demanded caused by a percent change in
price. As such, it measures the extent of movement along the demand curve. This elasticity is almost always
negative and is usually expressed in terms of absolute value. If the elasticity is greater than 1 demand is said to be
elastic; between zero and one demand is inelastic and if it equals one, demand is unit-elastic.
E=
The formula used to calculate the percentage change in quantity demanded is:
Similar to before, the formula used to calculate the percentage change in price is:
ELASTIC DEMAND - a change in price, results in a greater than proportional change in the quantity
demanded ED>1.
INELASTIC DEMAND - a change in price results in a less than proportional change ED<1.
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PERFECTLY ELASTIC DEMAND - demand changes even when price remains unchanged. ED=
PERFECTLY INELASTIC DEMAND - change in price does not result in any change.
ED=0
Income elasticity of demand measures the percentage change in demand caused by a percent change in
income. A change in income causes the demand curve to shift reflecting the change in demand. YED is a
measurement of how far the curve shifts horizontally along the X-axis. Income elasticity can be used to classify
goods as normal or inferior. With a normal good demand varies in the same direction as income. With an inferior
good demand and income move in opposite directions.(Represented by 'YED')[2]
Income elasticity of demand (Yed) measures the relationship between a change in quantity demanded and a
change in real income
% change in income
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This occurs when a change in income has NO effect on the demand for goods.
A rise of 5% income in a rich country will leave the Demand for toothpaste unchanged
The responsiveness of demand of one good to changes in the price of a related good either a substitute or a
complement
In economics, the cross elasticity of demand or cross-price elasticity of demand measures the responsiveness of the
demand for a good to a change in the price of another good.
It is measured as the percentage change in demand for the first good that occurs in response to a percentage change
in price of the second good. For example, if, in response to a 10% increase in the price of fuel, the demand of new
cars that are fuel inefficient decreased by 20%, the cross elasticity of demand would be
20%/10% = 2.
1. There is no way to state what the future will be with complete certainty. Regardless of the methods that we use
there will always be an element of uncertainty until the forecast horizon has come to pass.
2. There will always be blind spots in forecasts. We cannot, for example, forecast completely new technologies
for which there are no existing paradigms.
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3. Providing forecasts to policy-makers will help them formulate social policy. The new social policy, in turn, will
affect the future, thus changing the accuracy of the forecast.
Genius forecasting - This method is based on a combination of intuition, insight, and luck. Psychics and crystal
ball readers are the most extreme case of genius forecasting. Their forecasts are based exclusively on intuition.
Science fiction writers have sometimes described new technologies with uncanny accuracy
In this method consumers are contacted personally to disclose their future plans
so that we can able to forecast the future because they are ultimate targeters/buyers
So here large number of consumers will be there to get the unbiased information .The main
Advantage of this method is its accuracy and its main drawback is it is time consuming one.
d. SURVEY METHOD
Here from the total population certain number of units will be selected as sample units, then the
opinion collection will be made. This method is less tedious and less costly than the above method.
This method of estimating trend is elementary,easy and quick.It involves merely plotting of
annual sales on graph and then estimating just by observation where the trend line lies.
a. Trend extrapolation - These methods examine trends and cycles in historical data, and then use
mathematical techniques to extrapolate to the future. The assumption of all these techniques is that the
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forces responsible for creating the past, will continue to operate in the future. This is often a valid
assumption when forecasting short term horizons, but it falls short when creating medium and long term
forecasts. The further out we attempt to forecast, the less certain we become of the forecast
b. Simulation methods - Simulation methods involve using analogs to model complex systems. These
analogs can take on several forms. A mechanical analog might be a wind tunnel for modeling aircraft
performance. An equation to predict an economic measure would be a mathematical analog. A
metaphorical analog could involve using the growth of a bacteria colony to describe human population
growth. Game analogs are used where the interactions of the players are symbolic of social interactions
c. Trend Analysis: Uses linear and nonlinear regression with time as the explanatory variable, it is used
where pattern over time have a long-term trend. Unlike most time-series forecasting techniques, the Trend
Analysis does not assume the condition of equally spaced time series.
d. Simple Moving Averages: The best-known forecasting methods is the moving averages or simply takes a
certain number of past periods and add them together; then divide by the number of periods. Simple
Moving Averages (MA) is effective and efficient approach provided the time series is stationary in both
mean and variance. The following formula is used in finding the moving average of order n, MA(n) for a
period t+1,
e. Exponential Smoothing Techniques: One of the most successful forecasting methods is the exponential
smoothing (ES) techniques. Moreover, it can be modified efficiently to use effectively for time series with
seasonal patterns. It is also easy to adjust for past errors-easy to prepare follow-on forecasts, ideal for
situations where many forecasts must be prepared, several different forms are used depending on presence
of trend or cyclical variations. In short, an ES is an averaging technique that uses unequal weights;
however, the weights applied to past observations decline in an exponential manner
f. Least-Squares Method: To predict the mean y-value for a given x-value, we need a line which passes
through the mean value of both x and y and which minimizes the sum of the distance between each of the
points and the predictive line. Such an approach should result in a line which we can call a "best fit" to the
sample data. The least-squares method achieves this result by calculating the minimum average squared
deviations between the sample y points and the estimated line. A procedure is used for finding the values of
a and b which reduces to the solution of simultaneous linear equations. Shortcut formulas have been
developed as an alternative to the solution of simultaneous equations..
g. Regression and Moving Average: When a time series is not a straight line one may use the moving
average (MA) and break-up the time series into several intervals with common straight line with positive
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trends to achieve linearity for the whole time series. The process involves transformation based on slope
and then a moving average within that interval. For most business time series, one the following
transformations might be effective
Supply of a commodity refers to the various quantities of the commodity which a seller is willing and able to sell
at different prices in a given market at a point of time, other things remaining the same. Supply is what the seller is
able and willing to offer for sale. The Quantity supplied is the amount of a particular commodity that a firm is
willing and able to offer for sale at a particular price during a given time period.
1. The cost of factors of production: Cost depends on the price of factors. Increase in factor cost increases
the cost of production, and reduces supply.
2. The state of technology: Use of advanced technology increases productivity of the organization and
increases its supply.
3. External factors: External factors like weather influence the supply. If there is a flood, this reduces
supply of various agricultural products.
4. Tax and subsidy: Increase in government subsidies results in 43 more production and higher supply.
5. Transport: Better transport facilities will increase the supply.
6. Price: If the prices are high, the sellers are willing to supply more goods to increase their profit.
7. Price of other goods: The price of other goods is more than X then the supply of X will be increased.
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Responsiveness of producers to changes in the price of their goods or services. As a general rule, if prices rise so
does the supply.
Elasticity of supply is measured as the ratio of proportionate change in the quantity supplied to the proportionate
change in price. High elasticity indicates the supply is sensitive to changes in prices, low elasticity indicates little
sensitivity to price changes, and no elasticity means no relationship with price. Also called price elasticity of
supply.
Price elasticity of supply measures the relationship between change in quantity supplied and a change in price.
The formula for price elasticity of supply is:
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The value of price elasticity of supply is positive, because an increase in price is likely to increase the quantity
supplied to the market and vice versa. The elasticity of supply depends on the following factors:
SPARE CAPACITY
How much spare capacity a firm has - if there is plenty of spare capacity, the firm should be able to increase output
quite quickly without a rise in costs and therefore supply will be elastic
STOCKS
The level of stocks or inventories - if stocks of raw materials, components and finished products are high then the
firm is able to respond to a change in demand quickly by supplying these stocks onto the market - supply will be
elastic
Consider the sudden and dramatic increase in demand for petrol canisters during the recent fuel shortage. Could
manufacturers of cool-boxes or producers of other types of canister have switched their production processes
quickly and easily to meet the high demand for fuel containers?
If capital and labour resources are occupationally mobile then the elasticity of supply for a product is likely to be
higher than if capital equipment and labour cannot easily be switched and the production process is fairly
inflexible in response to changes in the pattern of demand for goods and services.
TIME PERIOD
Supply is likely to be more elastic, the longer the time period a firm has to adjust its production. In the short run,
the firm may not be able to change its factor inputs. In some agricultural industries the supply is fixed and
determined by planting decisions made months before, and climatic conditions, which affect the production, yield.
Economists sometimes refer to the momentary time period - a time period that is short enough for supply to be
fixed i.e. supply cannot respond at all to a change in demand.
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UNIT-III
Production Function Returns of Scale Production optimization Least cost output isoquants
Managerial uses of production function. Cost concepts Cost function Types of cost Determinants of
cost Short run and Long run cost curves Cost output Decision Estimation of Cost.
A production function is a function that specifies the output of a firm, an industry, or an entire economy for all
combinations of inputs. This function is an assumed technological relationship, based on the current state of
engineering.
The production function relates the output of a firm to the amount of inputs, typically capital and
labor
Q = f(X1,X2,X3,...,Xn)
where:
Q = quantity of output
X1,X2,X3,...,Xn = quantities of factor inputs (such as capital, labour, land or raw materials). This general form
does not encompass joint production; that is a production process that has multiple co-products or outputs
A standard production function which is applied to describe much output two inputs into a production process
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For capital K, labor input L, and constants a, b, and c, the Cobb-Douglas production function is:
f(k,n) = bkanc
If a+c=1 this production function has constant returns to scale. (Equivalently, in mathematical language, it would
then be linearly homogenous.) This is a standard case and one often writes (1-a) in place of c. Log-linearization
simplifies the function, meaning just that taking logs of both sides of a Cobb-Douglass function gives one better
separation of the components.
In the Cobb-Douglass function the elasticity of substitution between capital and labor is 1 for all values of capital
and labor
To simplify the interpretation of a production function, it is common to divide its range into 3 stages. In Stage 1
(from the origin to point B) the variable input is being used with increasing output per unit, the latter reaching a
maximum at point B (since the average physical product is at its maximum at that point). Because the output per
unit of the variable input is improving throughout stage 1, a price-taking firm will always operate beyond this
stage.
In Stage 2, output increases at a decreasing rate, and the average and marginal physical product are declining.
However the average product of fixed inputs (not shown) is still rising, because output is rising while fixed input
usage is constant. In this stage, the employment of additional variable inputs increases the output per unit of fixed
input but decreases the output per unit of the variable input. The optimum input/output combination for the price-
taking firm will be in stage 2, although a firm facing a downward-sloped demand curve might find it most
profitable to operate in Stage 1. In Stage 3, too much variable input is being used relative to the available fixed
inputs: variable inputs are over-utilized in the sense that their presence on the margin obstructs the production
process rather than enhancing it. The output per unit of both the fixed and the variable input declines throughout
this stage. At the boundary between stage 2 and stage 3, the highest possible output is being obtained from the
fixed input
Returns to scale: the change in percentage output resulting from a percentage change in all the factors of
production. They are increasing, constant and diminishing returns to scale.
Increasing returns to scale may arise: if the output of a firm increases more than in proportionate to an increase in
all inputs. For example the input factors are increased by 50% but the output has doubled (100%).
Constant returns to scale: when all inputs are increased by a certain percentage the output increases by the same
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percentage. For example input factors are increased by 50% then the output has also increased by 50 percentages.
Let us assume that a laptop consists of 50 components we call it as a set. In case the firm purchases 100 sets they
can assemble 100 laptops but it is not possible to produce more than 100 units.
Diminishing returns to scale: when output increases in a smaller proportion than the increase in inputs it is known
as diminishing return to scale. For example 50% increment in input factors lead to only 20% increment in the
output.
It is classified into three stages; let us understand the stages in terms of returns to scale.
Stage I:
The total production increased at an increasing rate. We refer to this as increasing stage where the total
product, marginal product and average production are increasing.
Stage II:
The total production continues to increase but at a diminishing rate until it reaches the next stage. Marginal
product, average product are declining but are positive. The total production is at the maximum level at the end of
the second stage with a zero marginal product.
Stage III:
In this third stage total production declines and marginal product becomes negative. And the average
production also started decline. Which implies that the change in input factors there is a decline in the over all
production along with the average and marginal. Our multiplier must always be positive, and greater than 1, since
we want to look at what happens when we increase production.
Benefits
2. Cost savings by avoiding unnecessary attention to areas that are non-critical, and improved focus on areas
of higher value
3. Discovery of enhancement opportunities during the conceptual and design phase, rather than later in the
projects life-cycle, when the cost of change is considerably higher
4. Systematic identification of key technological risks for a specific concept, and setting of priorities for
further technology development, qualification and testing (to reduce and manage these risks)
5. Improved insight into technical and managerial issues that may cause critical failures and production losses
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6. A road map on how to improve production capacities and production availability based on risk and cost-
benefit assessments.
MC =TC/Output
MC =PL/MPL
Since marginal revenue should be equal to the marginal cost at the profit-maximizing level,
A profit-maximizing firm always employs an input upto the point where its marginal revenue product equals its
cost.
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1. The firm can employ as much labor as it needs by paying workers $50 per period (the labor market is considered
perfectly competitive).
2. The firm can sell all the ore it can produce at a price of $10 per ton MRP = MFC = $50
3. In a case of less than six workers, MRP > MFC and the addition of more workers will increase revenue. Beyond
six, the opposite is true.
Since the slope is negative and one wishes to express the substitution rate as a positive quantity, a negative sign is
attached to the slope.
MRTS =Y1 - Y2/X1 - X2= Y/ X
OQUANT
In economics, an isoquant (derived from quantity and the Greek word iso, meaning equal) is a contour line
drawn through the set of points at which the same quantity of output is produced while changing the
quantities of two or more inputs. While an indifference curve mapping helps to solve the utility-
maximizing problem of consumers, the isoquant mapping deals with the cost-minimization problem of
producers. Isoquants are typically drawn on capital-labor graphs, showing the technological tradeoff
between capital and labor in the production function, and the decreasing marginal returns of both inputs.
Adding one input while holding the other constant eventually leads to decreasing marginal output, and this
is reflected in the shape of the isoquant. A family of isoquants can be represented by an isoquant map, a
graph combining a number of isoquants, each representing a different quantity of output. Isoquants are also
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An isoquant shows the extent to which the firm in question has the ability to substitute between the two
different inputs at will in order to produce the same level of output. An isoquant map can also indicate
decreasing or increasing returns to scale based on increasing or decreasing distances between the isoquant
pairs of fixed output increment, as you increase output. If the distance between those isoquants increases as
output increases, the firm's production function is exhibiting decreasing returns to scale; doubling both
inputs will result in placement on an isoquant with less than double the output of the previous isoquant.
Conversely, if the distance is decreasing as output increases, the firm is experiencing increasing returns to
scale; doubling both inputs results in placement on an isoquant with more than twice the output of the
original isoquant.
As with indifference curves, two isoquants can never cross. Also, every possible combination of inputs is
on an isoquant. Finally, any combination of inputs above or to the right of an isoquant results in more
output than any point on the isoquant. Although the marginal product of an input decreases as you increase
the quantity of the input while holding all other inputs constant, the marginal product is never negative in
the empirically observed range since a rational firm would never increase an input to decrease output.
A detailed study of cost analysis is very useful for managerial decisions. It helps the management
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7. To have a clear understanding of alternative plans and the right costs involved in them.
9. To decide and determine the very existence of a firm in the production field.
10. To regulate the number of firms engaged in production.
12. To find out decision making costs by reclassifications of elements, reprising of input factors etc, so as to fit
the relevant costs into management planning, choice etc.
Cost Determinants
The cost of production of goods and services depends on various input factors used by the organization and it
differs from firm to firm. The major cost determinants are:
1.Level of output: The cost of production varies according to the quantum of output. If the size of production is
large then the cost of production will also be more.
2.Price of input factors: A rise in the cost of input factors will increase the total cost of production.
3.Productivities of factors of production: When the productivity of the input factors is high then the cost of
production will fall.
4.Size of plant: The cost of production will be low in large plants due to mass production with mechanization.
5.Output stability: The overall cost of production is low when the output is stable over a period of time.
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6.Lot size: Larger the size of production per batch then the cost of production will come down because the
organizations enjoy economies of scale.
7.Laws of returns: The cost of production will increase if the law of diminishing returns applies in the firm.
8.Levels of capacity utilization: Higher the capacity utilization, lower the cost of production.
10.Technology: When the organization follows advanced technology in their process then the cost of production
will be low.
When cost is expressed in terms of money, it is called as money cost. It relates to money outlays by a firm
on various factor inputs to produce a commodity. In a monetary economy, all kinds of cost estimations and
calculations are made in terms of money only.
.Hence, the knowledge of money cost is of great importance in economics. Exact measurement of money cost is
possible.
When cost is expressed in terms of physical or mental efforts put in by a person in the making of a product,
it is called as real cost. It refers to the physical, mental or psychological efforts, the exertions, sacrifices, the pains,
the discomforts, displeasures and inconveniences which various members of the society have to undergo to
produce a commodity. It is a subjective and relative concept and hence exact measurement is not possible.
Explicit costs are those costs which are in the nature of contractual payments and are paid by an
entrepreneur to the factors of production [excluding himself] in the form of rent, wages, interest and profits, utility
expenses, and payments for raw materials etc. They can be estimated and calculated exactly and recorded in the
books of accounts. Implicit or imputed costs are implied costs. They do not take the form of cash outlays and as
such do not appear in the books of accounts. They are the earnings of owner employed resources.
Actual costs are also called as outlay costs, absolute costs and acquisition costs. They are those costs that
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involve financial expenditures at some time and hence are recorded in the books of accounts. They are the actual
expenses incurred for producing or acquiring a commodity or service by a firm. For example, wages paid to
workers, expenses on raw materials, power, fuel and other types of inputs. They can be exactly calculated and
accounted without any difficulty.
Opportunity cost of a good or service is measured in terms of revenue which could have been earned by
employing that good or service in some other alternative uses.
Direct costs are those costs which can be specifically attributed to a particular product, a department, or a
process of production. For example, expenses on raw materials, fuel, wages to workers, salary to a divisional
manager etc are direct costs. On the other hand, indirect costs are those costs, which are not traceable to any one
unit of operation. They cannot be attributed to a product, a department or a process.
For example, expenses incurred on electricity bill, water bill, telephone bill, administrative expenses etc.
Past costs are those costs which are spent in the previous periods. On the other hand, future costs are those
which are to be spent. in the future. Past helps in taking decisions for future.
Marginal cost refers to the cost incurred on the production of another or one more unit.
It implies additional cost incurred to produce an additional unit of output It has nothing to do
with fixed cost and is always associated with variable cost. Incremental cost on the other hand refers to the costs
involved in the production of a batch or group of output. They are the added costs due to a change in the level or
nature of business activity.
For example, cost involved in the setting up of a new sales depot in another city or cost involved in the
production of another 100 extra units.
Fixed costs are those costs which do not vary with either expansion or contraction in output. They remain
constant irrespective of the level of output. They are positive even if there is no production. They are also called as
supplementary or over head costs.
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On the other hand, variable costs are those costs which directly and proportionately increase or decrease
with the level of output produced. They are also called as prime costs or direct costs.
Accounting costs are those costs which are already incurred on the production of a particular commodity. It
includes only the acquisition costs. They are the actual costs involved in the making of a commodity. On the other
hand, economic costs are those costs that are to be incurred by an entrepreneur on various alternative programs.
It involves the application of opportunity costs in decision making.
Short-run cost curves are normally based on a production function with one variable factor of production
that displays first increasing and then decreasing marginal productivity. Increasing marginal productivity is
associated with the negatively sloped portion of the marginal cost curve, while decreasing marginal
productivity is associated with the positively sloped portion. The average fixed cost (AFC) curve is the cost
of the fixed factor of production divided by the quantity of units of the output,
While the average variable cost (AVC) curve cost traces out the per unit cost of variable factor of
production. The U-shaped average total cost (ATC) curve is derived by adding the average fixed and variable
costs. The marginal cost (MC) intersects both the AVC and ATC curves at their minimum points. Declining
average total costs are explained as the result of spreading the fixed costs over greater quantities and, at low
quantities, the result of the increasing marginal productivity, in addition. Increasing average costs occur when
the effect of declining marginal productivity overwhelms the effect of spreading the fixed costs.
The long-run cost curves, usually presented in a separate diagram, are also expressed most commonly in
their average, or per unit, form, represented here in Figure 2. The long-run average cost (LRAC) curve is
shown to be an envelope of the short-run average cost (SRAC) curves, lying everywhere below or tangent to
the short-run curves. The firm is constrained in the shortrun in selecting the optimal mix of factors of
production and so will never be able to find a cheaper mix than can be found in the long-run when there are no
constraints. If there are a discrete number of plant sizes available, the LRAC will be the scalloped curve
obtained by joining those parts of the
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Cost Calculations
Using the above abbreviations and Q for the quantity of output:
ATC = TC/Q
AFC = TFC/Q
AVC = TVC/Q
MC = change in TC/change in Q
Example: Lets suppose you are making 50 bottles of wine each week. You know that
your fixed costs add up to $300, and your variable costs amount to $900. You also know
that if you were to make extra 5 bottles, your total cost would rise by $60. What is your
total cost; average total cost; average total cost; average variable cost; average fixed cost;
and marginal cost?
Answer: Total cost = $300 + $900 = $1200
ATC = $1200/50 = $24
AVC = $900/50 = $18
AFC = $300/50 = $6
MC = $60/5 = $12
UNIT IV
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PRICING
Determinants of Price Pricing under different objectives and different market structures
price discrimination Pricing methods in practice Role of government in pricing control.
4.1 PRICE:
The price of a product or service is the number ofmonetary units a customer has to pay to receiveone unit of that
product or service (Simon 1989).
This was the traditional definition, but in the1990s a broader interpretation of the priceconcept became
customary. Illustrative of this
broader view is Hutt and Spehs observation thatthe cost of an industrial good includes much
more than the sellers price (Hutt and Speh 1998)
4.1.1 PRICING:
Pricing is the process of determining what a company will receive in exchange for its products. Pricing factors are
manufacturing cost, market place, competition, market condition, and quality of product. Pricing is also a key
variable in microeconomic price allocation theory. Pricing is a fundamental aspect of financial modeling and is one
of the four Ps of the marketing mix. The other three aspects are product, promotion, and place. Price is the only
revenue generating element amongst the four Ps, the rest being cost centers.
Pricing is the manual or automatic process of applying prices to purchase and sales orders, based on factors such
as: a fixed amount, quantity break, promotion or sales campaign, specific vendor quote, price prevailing on entry,
shipment or invoice date, combination of multiple orders or lines, and many others. Automated systems require
more setup and maintenance but may prevent pricing errors. The needs of the consumer can be converted into
demand only if the consumer has the willingness and capacity to buy the product. Thus pricing is very important
in marketing.
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number of subtypes):
Perfect Competition
Monopoly
Oligopoly
Monopolistic competition
Perfect Competition
where p stands for perfect, pure or price, whichever you may like.
A p-competitive structure is defined by four characteristics. For an industry to have a pcompetitive
structure, it must have all four of these characteristics, which are as follows:
Many buyers and sellers
A homogenous product
Sufficient knowledge
Free entry
These all are characteristics that favor price competition.
Many Buyers and Sellers
The idea is that the sellers and buyers are small relative to the size of the market, so that
no one of them can "fix the price." If there are "many small sellers," it makes it much
harder for any seller or group of sellers to "rig the price." Similarly, if there are "many
small buyers," there is little opportunity for buyers to "rig the price" in their own favor.
Homogeneity
If the product (or service) of one seller differed significantly from that of another seller, then each seller would
probably be able to retain at least some of the customers, even at a very high price. These would be the customers
who just prefer this seller's product (or service) to that of someone else. The assumption of homogenous products
serves to rule that out.
Knowledge
Some versions of the "perfectly competitive" structure include "perfect knowledge" as
one of its characteristics. But, of course, "perfect knowledge" never exists in reality.
Perfect information is little less clear than the other assumptions-- we can hardly assume
that people know everything there is to know.
Free Entry
Free entry means that new companies can set up in business to compete with established
companies whenever the new competitors feel that the profits are high enough to justify
the investment. This is, first and foremost, a legal condition. That is, in a "perfectly
competitive" market, there are no government restrictions on the entry of new
competition.
Let us sum up the four characteristics of p-competition:
1. Many small sellers-- The more the sellers, the more substitutes the consumer has.
2. Homogenous products-- When the product is homogenous, then the substitutes are
"perfect substitutes."
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3. Sufficient knowledge-- When customers know the prices offered by other sellers, they
will be better able to switch, increasing elasticity further.
4. Free entry-- In the long run, companies may even enter the market to provide still
more substitutes.
Other Market Forms
The other three market structure models can be defined in terms of the ways in which
they deviate from the characteristics of p-competition.
In a monopoly, there is just one seller of a good or service for which there is no close
substitute.
In an oligopoly, there are two or more, but only a few firms.
In monopolistic competition, the products are not homogenous but are "differentiated."
We do not have a standard model for "insufficient knowledge," but, at least in some
cases, that seems to work similarly to "product differentiation."
Market Structure Seller Entry Barriers Seller Number Buyer Entry Barriers Buyer Number
The correct sequence of the market structure from most to least competitive is perfect competition, imperfect
competition,oligopoly, and pure monopoly.
The main criteria by which one can distinguish between different market structures are: the number and size of
producers and consumers in the market, the type of goods and services being traded, and the degree to which
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Pricing policies are the decisions by a company determining prices to be charged for its products. There are
a number of different pricing policies or strategies which a firm may adopt in order to achieve its pricing
objectives.
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i. Skim pricing:
below cost, to penetrate the market, increases market share and eliminate competition.
the additional
distribution costs.
existing products.
irm has some spare capacity which it wishes to use without diverting a way from
capacity.
ial markers.
tc.
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x. Market pricing:
UNIT V
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Balance Sheet and related concepts Profit & Loss Statement and related concepts
Financial Ration Analysis Cash flow analysis Funds flow analysis Comparative
financial statements Analysis & Interpretation of Financial statements. Investments
Risks and return evaluation of investment decision m Average rate of return Payback
period Net present Value Internal rate of return
Richard Bowett introduces the important concept of the profit and loss account:
The starting point in understanding the profit and loss account is to be clear about the meaning of "profit".
Profit is the incentive for business; without profit people wouldn'tt bother. Profit is the reward for taking risk;
generally speaking high risk = high reward (or loss if it goes wrong) and low risk = low reward. People wont
take risks without reward. All business is risky (some more than others) so no reward means no business. No
business means no jobs, no salaries and no goods and services.
This is an important but simple point. It is often forgotten when people complain about excessive profits and
rewards, or when there are appeals for more taxes to pay for eg more policemen on the streets.
Accounting Principles:
Principle refers to the fundamental belief (or) a general truth which are established does not change
Accounting concepts
Business entity concept
Money measurement/Enterprise concepts
Going concern/ continuity concept
Cost concepts
Dual aspects of Concepts
A/c ing Period concepts
Revenue
Expenditure
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The Profit & Loss Account aims to monitor profit. It has three parts.
This records the money in (revenue) and out (costs) of the business as a result of the business trading ie buying
and selling. This might be buying raw materials and selling finished goods; it might be buying goods wholesale
and selling them retail. The figure at the end of this section is the Gross Profit.
This starts with the Gross Profit and adds to it any further costs and revenues, including overheads. These
further costs and revenues are from any other activities not directly related to trading. An example is income
received from investments.
3) The Appropriation Account. This shows how the profit is appropriated or divided between the three
1) The main use is to monitor and measure profit, as discussed above. This assumes that the information
recording is accurate. Significant problems can arise if the information is inaccurate, either through incompetence
or deliberate fraud.
2) Once the profit(loss) has been accurately calculated, this can then be used for comparison ie judging how well
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the business is doing compared to itself in the past, compared to the managers plans and compared to other
businesses.
3) There are ways to fix accounts. Internal accounts are rarely fixed, because there is little point in the
managers fooling themselves (unless fraud is going on) but public accounts are routinely fixed to create a good
impression out to the outside world. If you understand accounts, you can usually (not always) spot these fixes
and take them out to get a true picture.
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Complementing the balance sheet and income statement, the cash flow statement (CFS), a mandatory part of a
company's financial reports since 1987, records the amounts of cash and cash equivalents entering and leaving a
company. The CFS allows investors to understand how a company's operations are running, where its money is
coming from, and how it is being spent. Here you will learn how the CFS is structured and how to use it as part of
your analysis of a company.
A cash fl ow statement is one of the most important fi nancial statements for a project or business. The
statement can be as simple as a one page analysis or may involve several schedules that feed information into
a central statement.
A cash fl ow statement is a listing of the fl ows of cash into and out of the business or project. Think of it as your
checking account at the bank. Deposits are the cash infl ow and withdrawals (checks) are the cash outfl ows. The
balance in your checking account is your net cash fl ow at a specifi c point in time.
The cash flow statement is distinct from the income statement and balance sheet because it does not include the
amount of future incoming and outgoing cash that has been recorded on credit. Therefore, cash is not the same as
net income, which, on the income statement and balance sheet, includes cash sales and sales made on credit. (To
learn more about the credit crisis, read Liquidity And Toxicity: Will TARP Fix The Financial System?)
Cash flow is determined by looking at three components by which cash enters and leaves a company: core
operations, investing and financing,
Operations
Measuring the cash inflows and outflows caused by core business operations, the operations component of cash
flow reflects how much cash is generated from a company's products or services. Generally, changes made in cash,
accounts receivable, depreciation, inventory and accounts payableare reflected in cash from operations.
Cash flow is calculated by making certain adjustments to net income by adding or subtracting differences in
revenue, expenses and credit transactions (appearing on the balance sheet and income statement) resulting from
transactions that occur from one period to the next. These adjustments are made because non-cash items are
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calculated into net income (income statement) and total assets and liabilities (balance sheet). So, because not all
transactions involve actual cash items, many items have to be re-evaluated when calculating cash flow from
operations.
For example, depreciation is not really a cash expense; it is an amount that is deducted from the total value of an
asset that has previously been accounted for. That is why it is added back into net sales for calculating cash flow.
The only time income from an asset is accounted for in CFS calculations is when the asset is sold.
Changes in accounts receivable on the balance sheet from one accounting period to the next must also be reflected
in cash flow. If accounts receivable decreases, this implies that more cash has entered the company from customers
paying off their credit accounts - the amount by which AR has decreased is then added to net sales. If accounts
receivable increase from one accounting period to the next, the amount of the increase must be deducted from net
sales because, although the amounts represented in AR are revenue, they are not cash.
An increase in inventory, on the other hand, signals that a company has spent more money to purchase more raw
materials. If the inventory was paid with cash, the increase in the value of inventory is deducted from net sales. A
decrease in inventory would be added to net sales. If inventory was purchased on credit, an increase in accounts
payable would occur on the balance sheet, and the amount of the increase from one year to the other would be
added to net sales.
The same logic holds true for taxes payable, salaries payable and prepaid insurance. If something has been paid
off, then the difference in the value owed from one year to the next has to be subtracted from net income. If there
is an amount that is still owed, then any differences will have to be added to net earnings.
Investing
Changes in equipment, assets or investments relate to cash from investing. Usually cash changes from investing
are a "cash out" item, because cash is used to buy new equipment, buildings or short-term assets such as
marketable securities. However, when a company divests of an asset, the transaction is considered "cash in" for
calculating cash from investing.
Financing
Changes in debt, loans or dividends are accounted for in cash from financing. Changes in cash from financing
are "cash in" when capital is raised, and they're "cash out" when dividends are paid. Thus, if a company issues a
bond to the public, the company receives cash financing; however, when interest is paid to bondholders, the
company is reducing its cash.
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MEANING
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Horizontal Analysis
Vertical Analysis
Common-Size Statements
Trend Percentages
Ratio Analysis
CLOVER CORPORATION
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Increase
(Decrease)
Ca sh $ 12,000 $ 23,500
La nd 40,000 40,000
CLOVER CORPORATION
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Increase (Decrease)
ER CORPORATION
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Increase (Decrease)
Operating ratio
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Return on investment
Return of equity
Activityratios:
Balancesheetratios:
Current ratio
Liquidity ratio
UNIT VI
6.1 INVESTMENTS
It is the process of making investment decision in capital expenditures. Capital expenditure defined as an
expenditure the benefits of which are expected to be received more than one year. It is incurred in one point of
time and the benefits are received in different point of time in future.
Cost of acquisition of permanent asset as land and building, plant and machinery, goodwill
Cost of addition, expansion and improvement or alteration in fixed assets
Cost of replacement of permanent assets
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2.1.1 Why the capital budgeting is considered as most important decision over the others?
The capital budgeting is the decision of long term investments, which mainly focuses the acquisition or
improvement on fixed assets.
The capital budgeting decision is a decision of capital expenditure or long term investment or long term
commitment of funds on the fixed assets.
2.1.2 Principles
- Capital expenditure decision are long-term and have effect on profitability of a concern
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- Not only present earning but also the future growth and profitability of the firm depends on investment decision
taken today
- Capital budgeting is needed to avoid over investment or under investment in fixed assets.
- Long term investment decision are difficult to take because (i) decision extends to a series of year beyond the
current accounting period
- (ii) uncertainties of future
- (iii) higher degree of risk
- Investment decision taken by individual concern is of national importance because it determines employment,
economic activities and economic growth.
Capital budgeting is a difficult process to the investment of available funds. The benefit will attained
only in the near future but, the future is uncertain. However, the following steps followed for capital
budgeting, then the process may be easier are.
Evaluation of Proposals
Fixing Property
Final Approval
Implementation
1.Identification of various investments proposals: The capital budgeting may have various
investment proposals. The proposal for the investment opportunities may be defined from the top
management or may be even from the lower rank. The heads of various department analyse the
various investment decisions, and will select proposals submitted to the planning committee of
competent authority.
2. Screening or matching the proposals: The planning committee will analyse the various proposals
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and screenings. The selected proposals are considered with the available resources of the concern. Here
resources referred as the financial part of the proposal. This reduces the gap between the resources
and the investment cost.
3.Evaluation: After screening, the proposals are evaluated with the help of various methods, such as
pay back period proposal, net discovered present value method, accounting rate of return and risk
analysis.
4. Fixing property: After the evolution, the planning committee will predict which proposals will give
more profit or economic consideration. If the projects or proposals are not suitable for the concerns
financial condition, the projects are rejected without considering other nature of the proposals.
5.Final approval: The planning committee approves the final proposals, with the help of the
following:
(a) Profitability,
(b) Economic
(c) Financial
6. Implementing: The competent authority spends the money and implements the proposals. While
implementing the proposals, assign responsibilities to the proposals, assign responsibilities for completing it,
within the time allotted and reduce the cost for this purpose. The network techniques used such as
PERT and CPM. It helps the management for monitoring and containing the implementation of the
proposals.
7. Performance review of feedback: The final stage of capital budgeting is actual results compared
with the standard results. The adverse or unfavourable results identified and removing the various
difficulties of the project. This is helpful for the future of the proposals.
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This method represent the period in which total investment in permanent asset pays back itself. It measure
the period of time for the original cost of a project to be recovered from the additional earning of a project itself.
Investment are ranked according to the length of the payback period, investment with shorter payback
period is preferred.
Calculate annual net earnings(profit) before depreciation and after taxes, these are called annual cash
inflow
Divide the initial outlay(cost) of the project by the annual cash inflow, where the project generates constant
annual cash inflow
Payback period = cash outlay of the project or original cost of the asset
Annual cash inflows
Where the annual cash inflows (profit before depreciation and after taxes) are unequal the payback period is found
by adding up the cash inflows until the total is equal to the initial cash outlay of the project.
Selection criterion
PPPI =
Merits
It is a simple method to calculate and understand
It is a method in terms of years for easier appraisal
Demerits
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It is a method rigid
It has completely discarded the principle of time value of money
It has not given any due weight age to cash inflows after the payback period
It has sidelined the profitability of the project.
2.4.2 Average Rate of Return method (ARR)
This method takes in to account the earnings expected from the investment over their whole life. It is
known as accounting rate of return.
The project which gives the higher rate of return is selected when compared to one with lower rate of
return.
.
Merits
It is simple method to compute the rate of return
Average return is calculated from the total earnings of the enterprise through out the life of the firm
The entire rate of return is being computed on the basis of the available accounting data
Demerits
Under this method, the rate of return is calculated on the basis of profits extracted from the books but not on the
basis of cash inflows
The time value of money is not considered
It does not consider the life period of the project
The accounting profits are different from one concept to another which leads to greater confusion in determining
the accounting rate of return of the projects
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It is a modern method of evaluating investment proposals. It takes into consideration time value of money
and calculates the return on investment by introducing the factor of time element.
First determine the rate of interest that should be selected as the minimum required rate of return
Compute the present value of total investment outlay
Compute the present value of total cash inflows
Calculate Net Present Value by subtracting the present value of cash inflow by present value of cash
outflow.
NPV = is positive or zero the project is accepted
NPV= is negative then reject the proposal
In order for ranking the project the first preference is given to project having maximum positive net present
value
NPV= Present value of cash inflow present value of cash outflow/Initial investment
Under the internal rate of return method, the cash flows of a project are discounted at a suitable rate by hit
and trial method, which equates the net present value so calculated to the amount of investment.
Determine the future net cash flows during the entire economic life of the project. The cash inflows are
estimated for future profits before depreciation but after taxes
Determine the rate of discount at which the value of cash inflow is equal to the present value of cash
outflows
Accept the proposal if the internal rate of return is higher than or equal to the cost of capital or cut off rate.
In case of alternative proposals select the proposal with the highest rate of return.
It is also called Benefit cost ratio is the relationship between present value of cash inflow and present value
of cash outflow
Initial investment
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The proposal is accepted if the profitability index is more than one and is rejected the profitability index is less
than one
The various projects are ranked; the project with higher profitability index is ranked higher than other.
PI =
h outflow.
1. Calculate the average rate of return for Projects X and Y from the following
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2. Calculate the NPV of 2 projects and suggest which of 2 projects should be accepted assuming a
discount rate 10%
Particular Project X Project Y
The profit before dep. & Tax, cash flows are as follows
Year 1 2 3 4 5
Solution
Project X
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120000 40000 80000 32000 48000 88000
Project Y
NPV = 4724
Comment:
NPV of project y is higher than the NPV of project x. Hence, it is suggested that project y should be
selected.
3. Initial outlay Rs. 50000, life of an asset 5 years Annual cash flow Rs. 12500, Calculate IRR
Present value Factor = = =4
IRR = 8 %
Illustration
When the annual cash flows over the life of the asset.
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Workings:
15% = 715 (60000 59285)
14% = 595 (60595 60000)
14 +
14+
14+0.45 (1)
IRR = 14.45 %
Question Bank
Part A
UNIT I
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By combining the basic definition of the two terms Manager and Economics you get the
definition of managerial economics . Managerial Economics is the study of directing resources in a way that it
most efficiently achieves the managerial goals.
Managerial Economics is also the application of the tools of economics analysis in decision making
in actual business situations.
Micro economic analysis deals with the problems of an individual firm, industry or consumer etc. It
helps in dealing with issues which go on within the firm such as putting the resources available with the firm to its
best use, allocating resources within various activities of the firm to its best use, allocating resources within
various activities of the firm and also deals with being technically and economically efficient.
Prescriptive or normative approach tells How things ought to be done. 4. What is meant by
descriptive approach ?
The objectives of a business firm may be varied. Apart from generating profits a firm has many other
objectives like being a market leader , being a cost leader, achieving superior efficiency, achieving superior
quality, achieving superior customer responsiveness etc.
Supply analysis deals with the various aspects of supply of a commodity. Certain important aspects of
supply analysis are supply schedule, curves and function, elasticity of supply, law of supply and its limitations and
factors influencing supply.
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Engineering economics accomplishes several objectives. It presents the aspects of traditional economics
that are relevant for business and engineering decision making in real life.
10.Define Logistics:
It is the movement of finished goods to wholesaler or retail outlets and to the final consumers.
Statistics provide the basis for empirical testing of theory. Generalizations or theory cannot be accepted for
practice unless these theories are checked against the data from the reality. This way, theories become more
practical and useful in real life business situation.
Economics has two divisions namely micro economics and macro economics. Micro economics is the
branch of economics where the unit of study is an individual or a firm while macro economics is branch of
economics where the unit of study is aggregative in character and considers the entire economy.
Many of the theories in mathematics will find use in economics. Concepts such as calculus, vectors,
logarithms and exponentials, determinants and matrix, algebra etc are some to name a few. Managerial economics
is metrical in character. It estimates various economic relationships prediction relevant economic quantities and
uses them in decision making and planning for the future. So mathematics becomes an important tool in
managerial economics.
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Operations research was developed as science during the Second World War to solve the complex
operations problems of planning and resource allocation in defence and in basic industries which specifically
supplied military equipments. These theories find high usage in various field of management to solve problems
pertaining to logistics, both inbound and outbound and also the movement of material within the factory premises
etc.
The competitors of the firm are also likely to react or even pro-act to any decisions made by the firm. Competitors
always try to navigate the competitive advantage gained by the firm. Thus managers will have to make wise
investments in projects that will be hard to be imitated by the competition.
Most of the business decisions taken by the managers are done under uncertainty. Uncertainties
pertaining to demand, cost, price, profit, capital etc prevail most of the time when decisions are made. This makes
the whole decision making process difficult and complex. The tools used in economic analysis have been modified
and refined so as to take into account the uncertainty and thus help decisions making in logical and scientific
manner.
All business firms are motivated and committed to produce profits. Profits are one of the tangible
yardsticks to measure the performance of the firm and the managers concerned. It also signifies the health of the
firm. Profits are influenced by various factors such as cost of production, revenues and other factors both internal
and external to the firm. Profits are hard to predict.
A firms profitability and success greatly depend on the pricing decisions and the pricing policies of the
firm. The patronization of the firms products by the customers, the competition faced by the product along with
the profits of the firm, largely depends on the price of the product. Pricing also depends on the environment in
which the firm operates, competitions, customers etc.
When a manager organizes and plans the firms production functions i.e. when he tries to convert the raw
materials to finished product, he faces a number of economic problems. The study of production function
describes the input output relationship.
One way to earn higher profits is by controlling the cost involved in producing the product. Study of cost
is necessary for making efficient and effective managerial decisions. If a detailed cost analysis and estimation is
done, the firm can move upon effective profit management and sound pricing practices.
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(a) The economy in which firms operate is predominantly a free enterprise economy.
(b) The present day economy is undergoing rapid technological and economic changes and,
(c) The government intervening in the economic affairs has increased in the recent times and is
likely to go up further.
1.Managerial economics deals with the decision making by managers, executives and engineers of
economic nature.
2.Managerial economics is goal oriented.
3.Managerial Economics is both conceptual and metrical.
4.Managerial economics is pragmatic.
16 MARKS
Statistics
Management
Operational research mathematics
Accounting psychology
4. Descriptive &prescriptive
5. Appliedscience
Formulation of theories
Cause &effect relationship
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Allocation of resources
To use micro economic concepts
Effective decision making
Fundamental questions
What to produce?
How to produce
For when to produce?
Production &cost analyst
Market structure
Profit & non-profit organization
Firms:
It is a unit that produces a goods (or) services for a sale.
Types of firms
Private sector (owned by private people)
1. Sole proprietorship (single owner)
2. Partnership (more than one people)
3. Joint stock (companies act)
4. Cooperatives. (Voluntary organization with non-profit motives)
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UNIT II
DEMAND AND SUPPLY ANALYSIS
1.Define Demand.
Demand indicates the quantities of products (goods service) which the firm is willing and financially able
to purchase at various prices, holding other factors constant.
An individuals demand for a commodity depends on his desire and capability to purchase it. Apart from
the desire to purchase, there are many other factors which influence the purchase of a product (demand). These are
known as demand determinants.
The change of tastes and preferences of consumers in favor of a commodity will result in a greater demand
for the commodity. The opposite also holds good i.e. if the tastes and preferences of consumer change against the
commodity, the demand will suffer.
Consumers have two kind of expectations one pertains to their future income and the second is related to
the future prices of the goods and its related goods.
5. Define Advertising
Advertisements provide information about the presence of quality products in the market and induces
customers to buy more. It also promotes the latest preferences of the general public to masses.
The relation of price to quantity demanded / sales is known as the law of demand. Law of demand
states that the higher the price is the lower the demand is and vice versa, holding other factors as constant.
This price quantity relation can be expressed as demand being a function of price
D=f(p).
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Factors shift the demand for a particular product either on the right side of the demand curve or to
the left side of the demand curve based on the changes in price. These factors, other than the price of a good that
influence demand are known as demand shifters. The shift in the demand either to the left or right is called the
demand shift.
1. In share markets on would have noticed that the rise in price of the shares increases, the sales of
the shares while decrease in the price of the shares results in decrease of sale of the shares.
2. Some goods which act as status symbol and have a snob appeal fall under this category. Here
when the price of the product rises then the appeal of the product also rises and thus the
demand. Some example are diamonds and antiques.
3. Finally, ignorance on the part of the consumer may cause the consumer to buy at a higher price,
especially when the rise in price is taken to mean an improvement in quality and a reduction in
price as deterioration in quality.
11.Define Individual demand :
The quantity of a product demanded by an individual purchaser at a given price is known as individual
demand.
The total quantity demanded by all the purchasers together is known as the market demand.
1. Consumption function
2. Product consumption function
3. Differences in regional incomes
4. Income expectation and demand
14. What are the Characteristics of demand function ?
1. The long run relationship between consumption and income is some what stable, and
expenditure on consumption is usually about 85 to 90% of the income.
2. The consumption function is highly unstable in short runs and the relationship between income
and consumption cannot be predicted by any mathematical formula.
3. During the periods of economic prosperity, there is an absolute increase in the expenditure on
consumption, but decrease as a percentage of income during periods of depression, the
consumption declines absolutely but the expenditure on the consumption increases as a
percentage of income.
4. In the periods of economic recovery, the rate of increase in consumption is higher than the rate
of the decline in consumption in times of recession.
15. Define Product consumption function:
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This function can be defined as the relationship between the total income of the consumer and sales
of particular products. It means that when there is a change in income there is a change in the demand for
particular products.
Expectations are related to peoples estimates of the level and durability of the future economic
conditions. The demand for many consumer durables (household appliances like TV, Washing machine, etc) is
often sensitive to general expectations regarding income level.
1. Even when there is no advertising effort done, there will be a certain amount of sales possible
for a particular product by virtue of its presence in the market.
2. There is a direct relationship between advertising and sales. Thus when there is an increased
spending on advertisements. It will bring in more sales.
3. Increase in advertisements will lead to more than proportionate increase in sales only to a point.
After that any increase in advertisement will have only less than proportionate effect on sales.
Elasticity of demand is defined as the percentage change in quantity demanded caused by one percent
change in the demand determinant under consideration, while other determinants are held constant.
It is the degree of change in demand to the degree of change in any of the demand determinants.
Price elasticity of demand can be defined as the degree of responsiveness of quantity demanded to
a change in price.
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Absolutely inelastic demand is where a change in price howsoever large, causes no change in the quantity
demanded of a product. Here, the shape of the demand curve is vertical.
It is where a reduction in price leads to more than proportionate change in demand. Here the shape of the
demand curve in flat.
16 MARKS
1. i. Define law of demand &explain the types of demand.
According to Marshall, The amount demanded increases with a fall in price and diminishes with a rice in
price, other remaining constant.
Types of Demand
substitution effect
income effect
new consumer creating demand
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price effect
different uses
________________________
1.Completely (Perfectly) Inelastic supply: In this case the quantity supplied does not react to the changes in
the price. The increase or decrease in the price does not change the quantity supplied.
2.Completely (Perfectly) Elastic supply: When a minuscule change in price results in infinite change in the
quantity supplied then it is a case of completely elastic supply. For instance when there is marginal rise in the
price, then the quantity supplied rises infinitely.
Unitary Elastic supply: When the proportionate change in quantity supplied is equal to the proportionate
change in the price of the commodity then we call it as unitary or unit elasticity of supply.
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4.Relatively Inelastic supply: When the percentage change in quantity supplied is less than the proportionate
change in price than it is a case of relatively inelastic supply.
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Perfectly Elastic demand ( E=)Demand change but price does not change
If the demand for a commodity does not change in spite of an increase or decrease in its price
It is defined as the percentage change in the quantity demanded of a good divided by the percentage change in
the income of the consumer,
Ey= Q Y
_____ * ______
Y Q
A change in demand for one good in response to a change in the price of another good .
Ec= Qx Py
_____ * ______
Py Qx
It is a measure of the responsiveness of demand for a commodity to the change in outlay on advertisements
and other promotional efforts
Ea= Dx A
_____ * ______
A Dx
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1. Percentage Method
It measures the percentage change in the quantity of a commodity demanded resulting from a given percentage
change in its price
Ep= % change in q p
_____________ * ____
% change in P q
2. Point Method or Geometric Method
It measures the elasticity of demand on different points of a demand curve. It is a variant proportionate method.
Ep= P.Q
_____
Q.P
3. Arc Method
segment of a demand curve between two points is called Arc.
Ep= Q P
_____ + ______
Q1+Q2 P1+P2
Where
Q= change in quantity demanded
P= Change in price of the commodity
P1= Original price
P2=New Price
Q1=Original quantity
Q2=New quantity
4. Total outlay Method
It is measured on the basis of change in total outlay or total expenditure in response to change in the price
of the commodity
Types:
Unitary Elasticity: Small changes in price unaffected the total outlay
Elastic demand: Small changes in price increases the total outlay
Inelastic demand: Small changes in price decreases the total outlay
5. Revenue Method
It refers to the sale proceeds of a firm.
Ep= A
_____
A-M
Where,
Ep=Stands for elasticity of demand
A=Stands for average revenue
M=Stands for Marginal revenue
2.Income Elasticity of Demand
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It is defined as the percentage change in the quantity demanded of a good divided by the percentage change in the
income of the consumer,
Ey= Q Y
_____ + ______
Y Q
Where,
Ey= stands for income elasticity
Q=stands for quantity demanded
Y=stands for income
Q= Gives change in quantity demanded
Y = Gives change in income
Types of Income Elasticity of demand
1.High Income elasticity : If Income increases in high and quantity demand also good increases
2. Unitary Income elasticity: Changes in income and quantity demanded are same
3. Low Income elasticity: If Income increases in low and quantity demand also good increases
4.Zero Income elasticity: No change in quantity demanded by the changes in income
5.Negative Income elasticity: Increase in income results in decreases in quantity demanded
3. Cross elasticity of demand
A change in demand for one good in response to a change in the price of another good .
Ec= Qx Py
_____ * ______
Py Qx
Where,
Ec=stands for cross elaticity
Qx= changes in quantity demanded
Py=original price of good y
Py=small changes in price of y
Qx=changes in quantity demanded
Applications of cross elasticity in management
a. In Production
b. Demand forecasting and pricing
c. In international trade and balance of payments
4. Advertising and promotional elasticity of demand
It is a measure of the responsiveness of demand for a commodity to the change in outlay on advertisements and
other promotional efforts
Ea= Dx A
_____ * ______
A Dx
Factors determining advertising elasticity of demand
Type of commodity
Market share
Rivals reactions
State of economy
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1. Qualitative model
a. Delphi Technique
A systematic forecasting method that involves structured interaction among a group of experts on a
subject.
The Delphi Technique typically includes at least two rounds of experts answering questions and
giving justification for their answers, providing the opportunity between rounds for changes and revisions.
b. Nominal group technique
The nominal group technique (NGT) is a group process involving problem identification, solution generation,
and decision making.
c. Marketing research method
The process or set of processes that links the consumers, customers, and end users to the marketer
through information information used to identify and define marketing opportunities and problems and improve
understanding of marketing as a process.
d. Sales force composite method
A technique used
by production managers to project the future demand for a good or service based on the total amount that
each salesperson anticipates being able to sell in their region.
2. Quanitative model
I. Time Series Models
a. Last period Method
Uses last periods actual value as a forecast
Ft= At 1
Ft = Forecast demand for period t
At-1= Actual demand in previous period
b. Simple Average Method
n
Ft= At
t=1
_________ (OR)
n
Ft = A1+A2+A3+A3+A4+.+An
_______________________
n
Ft =Forecasted demand for period t
At= Actual demand for period t
n= Total no of periods
c. Moving average method
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Uses an average of a specified number of the most recent observations, with each observation receiving a different
emphasis (weight)
ft= At-1 + At-2 + At-3 + At-4+At-5 +.Atn
________________________________
n
Where
Ft- Forecasted demand for period t
At- Actual demand for period t
n- Total no of periods
d. Exponential smoothing method
A weighted average procedure with weights declining exponentially as data become older.
Ft = Ft-1 + (At-1 Ft-1)
Where
Ft Forecasted demand for period t
Ft-1 forecasted demand for previous method
- Smoothening constant
At-1- Actual demand for previous demand
e. Trend Project( Past data/ Predicting the future)
This method is a version of the linear regression technique.
Y = a + bX
Where
X represents the values on the horizontal axis (time)
Y represents the values on the vertical axis (demand).
2. Cause and Effect Model
a. Correlation and Regression method
Linear regression is a mathematical technique that relates one variable, called an independent variable, to
another, the dependent variable,
Y = a + bX
Y- independent variable
X- Dependent variable
a- the intercept
B- slope of the line
b. Econometric Method
It includes endogenous determined within the model ( controlled variables) and exogenous variable-determined
outside the model(uncontrolled variables)
eg., Money
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UNIT III
1. Say some of the main cost concepts.
1) Actual costs and opportunity costs
2) Incremental costs and sunk costs
3) Explicit costs and implicit costs
4) Past costs and future costs
5) Accounting costs and economic costs
6) Direct cost and indirect cost
7) Private costs and social costs
8) Controllable costs and non controllable costs
9) Replacement costs and original costs
10) Shutdown costs and abandonment costs
11) Urgent costs and postponable costs
12) Bussiness costs and full sosts
13) Fixed costs and variable costs
14) Short run and long run costs
15) Incremental costs and marginal costs
2. What are actual costs and opportunity costs ?
Actual costs which a firm incurs for producing or acquiring a product or a service. As example for this is
the cost on raw materials, labor, rent, interest.
3. What are incremental costs and sunk costs ?
Incremental cost is the additional cost due to change in the level of nature or business activity. Sunk costs
are the costs that are not altered by a change in quantity produced and cannot be recovered.
4. What are Explicit costs and implicit costs ?
Explicit or paid out costs are those expenses which are actually paid by the firm. Implicit costs are the
theoretical costs in the sense that they go unrecognized by the accounting system.
5. What are past costs and future costs ?
Past costs are the actual costs incurred in the past are generally contained in the financial accounts. Future
costs are costs that are expected to occur in some future period or periods.
6. What are accounting costs and economic costs ?
Accounting costs are the actual outlay costs. Economic cost relate to the future,
7. What is direct and indirect cost ?
Direct cost are traceable cost or assignable cost are the ones that have direct relationship with a unit of
operation like a product, a process or a product, or a department of the firm. On the otherhand, indirect
costs or non traceable costs or common or non assignable costs are the costs whose course cannot be easily
and definitely traced to the plant.
8. What are private costs and social costs ?
Private costs are those which are actually incurred or provided for the business activity by an individual or
the business firm. Social costs on the otherhand are the total costs to the society on account of production
of a good.
9. What are controllable and non controllable costs ?
Controllable costs are those which are capable of being controlled or regulated by the managers ant = d it
can be used to assess the managerial efficiency in controlling the cost in his department. Non controllable
costs are those which cannot be subjected to administrative controls and supervision.
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Incremental cost is important when dealing with decisions where discrete alternatives are to be
compared.marginal cost deals with unity unit output.
1) level of output
2) price of inputs.
3) size of plant
4) output stability
7) technology
8) learning effect
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The higher the capacity utilization fixed cost per unit of output in bound to be low.
Stability of output leads to savings in various kinds of hidden cost interruption and learning.
Production costs are usually lower in bigger plants than smaller plants.
23)what is cost?
Cost is the money spent on producing and selling a product to the customers.the cost of a product starts from
the raw materials through production costs till selling costs include the cost in maintaining outlets.
Study of costs is essential for making a choice from among the competing production plans.production
decisions are not possible without their respective cost considerations.
If the price of the raw materials labor,power increases then naturally the cost of production goes up.this cost
of productions varies directly with the prices of inputs.
16 MARKS
Increasing return
Negative return
Decrasing return
iso quants
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For example, in year one, a firm employs 200 workers, uses 50 machines, and produces 1,000
products. In year two it employs 400 workers, uses 100 machines (inputs doubled), and produces 1,500
products (output less than doubled).
Constant Returns to Scale
Constant returns to scale occurs when the firm's output rises proportionate to the increase in
inputs.
Constant or same output.
Actual costs are also called as outlay costs, absolute costs and acquisition costs.
They are those costs that involve financial expenditures at some time and hence are recorded in the books
of accounts.
o They are the actual expenses incurred for producing or acquiring a commodity or service by a firm.
o For example, wages paid to workers, expenses on raw materials, power, fuel and other types of inputs.
They can be exactly calculated and accounted without any difficulty.
Opportunity cost of a good or service is measured in terms of revenue which could have been earned by
employing that good or service in some other alternative uses.
Direct costs are those costs which can be specifically attributed to a particular product, a department, or a process
of production.
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MG245 ENGINEERING ECONOMICS AND FINANCIAL ACCOUNTING
indirect costs are those costs, which are not traceable to any one unit of operation. They cannot be attributed to a
product, a department or a process
Explicit costs are those costs which are in the nature of contractual payments and are paid by an entrepreneur to
the factors of production [excluding himself] in the form of rent, wages, interest and profits, utility expenses, and
payments for raw materials etc.
Implicit or imputed costs are implied cost.They do not take the form of cash outlays and as such do not appear in
the books of accounts. They are the earnings of owner employed resources.
Accounting costs are those costs which are already incurred on the production of a particular commodity.It
includes only the acquisition costs.
Economic costs are those costs that are to be incurred by an entrepreneur on various alternative programs.
accounting concept
engineering concept
statistical cost
3. Explain about cost out put relation in short run &long run with neat sketch.
Short-run cost curves are normally based on a production function with one variable factor of production
that displays first increasing and then decreasing marginal productivity.Increasing marginal productivity is
associated with the negatively sloped portion of the marginal cost curve, while decreasing marginal
productivity is associated with the positively sloped portion. The average fixed cost (AFC) curve is the cost
of the fixed factor of production divided by the quantity of units of the output, while the average variable
cost (AVC) curve cost traces out
the per unit cost of variable factor of production.The U-shaped average total cost (ATC) curve is derived
by adding the average fixed and variable costs. The marginal cost (MC) intersects both the AVC and ATC
curves at their minimum points. Declining average total costs are explained as the result of spreading the
fixed costs over greater quantities and, at low quantities, the result of the increasing marginal productivity,
in addition. Increasing average costs occur when the effect of declining marginal productivity overwhelms
the effect of spreading the fixed costs.
LONG RUN:
The long-run cost curves, usually presented in a separate diagram, are also expressed most commonly in
their average, or per unit, form, represented here in Figure 2. The long-run average
cost (LRAC) curve is shown to be an envelope of the short-run average cost (SRAC) curves, lying
everywhere below or tangent to the short-run curves.
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The firm is constrained in the shortrun in selecting the optimal mix of factors of production and so will
never be able to find a cheaper mix than can be found in the long-run when there are no constraints. If there
are a discrete number of plant sizes available, the LRAC will be the scalloped curve obtained by joining
those parts of the SRAC curves that represent the lowest cost of production for a given quantity.
5. Calculate the Total, Average and Marginal Costs for the following data.
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1 60 20 80 20 60 80 20
2 60 36 96 18 30 48 16
3 60 48 108 16 20 36 12
4 60 64 124 16 15 31 16
UNIT-IV
2) internal factors
1) The costs
2) Management policy towards the gross margin and the sales turnover
1)objectives of business
2)competition
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6)Routinisation of pricing
7)Government regulation
The fundamental objective of a firm is to survive in the business and then thrive.The pricing strategy adopted
by a firm is very much by these factors.
To come out with a pricing policy that will be advantages to the firm,managers require a perfect understanding
of the competitive environment in which the firm is placed.
i. product itself
ii. pricing
We know that many factors contribute to the increase of price sensitivity,but managers should not ignore the
factors that minimize price sensitivity .when designing pricing strategies.
Middlemen are the ones who stock the finished product of the manufacturer to sell it to the customers.these are
also called the channel for distribution.
This strategy of pricing relies on the tried and trusted pricing strategies which the organization has
followed all along. This pricing practice is often routinized but the extend varies from company to company and
from product to product.
Inorder to safeguard the interests of the public the government acts on their behalf to prevent the abuse of
the monopolistic power and collusion among business.
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i. profit maximization.
iii.customery pricing.
vi.cyclical pricing.
vii.imitative pricing.
viii.turnover pricing.
i.administered pricing.
ii.dual pricing.
i) cost plus.
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In going rate pricing the emphasis is on the market situation unlike the full cost pricing where the
emphasis was on costs.
The pricing method which is done to capitalize on the cycles of the season in nature and the cycle
in the economy are known as cyclical pricing.
It is very similar to the loss leader pricing method. This pricing policy is often used in retail
business.
Turnover is the word which denotes the sales of the product. The higher the turnover means
higher the sales.
Usually the firms which produce essential commodities have part of their product under
administrating pricing and part of the product is solid in the free market.
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Price is the source of revenue for the firm and it decides the health of the firm.the customer acceptance or
rejection of a product is most of the time predominantly influenced by price.
27) What are the external factors influencing the prcising decision?
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in companies,old
people are more likely to be poor
price discrimination is likely to
increase output and make the good or service available to more people and the increased competition in the
market leads to lower prices and more choice.
Types of Price Discrimination:
First degree price discrimination:
In first degree price discrimination, price varies by customer's willingness or ability to pay.
This arises from the fact that the value of goods is subjective.
Second degree price discrimination:
In second degree price discrimination, price varies according to quantity
sold. Larger quantities are available at a lower unit price.
Peak and Off-Peak Pricing:
Peak and off-peak pricing are common in the telecommunications industry, leisure retailing and in the
travel sector.
Telephone and electricity companies separate markets by time: There are three rates for telephone calls: a
daytime peak rate, and an off peak evening rate and a cheaper weekend rate.
Third degree price discrimination:
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In third degree price discrimination, price varies by attributes such as location or by customer
segment, or in the most extreme case, by the individual customer's identity.
Disadvantages of Price Discrimination:
1. Some consumers will end up paying higher prices.
2. Those who pay higher prices may not be the poorest
Pricing policies are the decisions by a company determining prices to be charged for its products. There are a
number of different pricing policies or strategies which a firm may adopt in order to achieve its pricing objectives.
i. Skim pricing:
below cost, to penetrate the market, increases market share and eliminate competition.
the additional
distribution costs.
existing products.
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irm has some spare capacity which it wishes to use without diverting a way from
capacity.
ial markers.
tc.
x. Market pricing:
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a.Stay-out Pricing:
o When a firm is not certain about the price at which it will be able to sell its product, it
o If at this high price quotation it is not able to sell, it then lowers the price of its
product.
o It will keep on lowering the price till it is able to sell the targeted amount of the
product.
b. Price lining:
o Here, price of one product in the total range of the products is fixed.
between the commodity whose price has been fixed and the rest of the commodities
in the range.
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o Here a firm fixes the price of its product in a manner which gives the impression of
being low.
o For example, if the price of a product is fixed at Rs. 89.90 rather than Rs. 90, it may
have the psychological impact on consumers that price is in 80s rather than in 90s.
d. Limit Pricing:
o A firm (or firms) may also try to establish a price that reduces or eliminates the threat
of entry of new firms into the industry. This is called limit pricing.
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o For limit price to be effective some of collusion is necessary among existing firms.
o The manufacturers of such products fix and stipulate the price of the products at
o This is done to maintain a uniform selling price of the branded produces at all the
f. Peak-load pricing:
o A firm that uses the same facility to supply many markets at different points of time
o Peak-load pricing essentially involves charging higher price from consumers wanting
to consume the service during the peak demand period and lower price from those
g. Multi-product Pricing:
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o Pricing that reflects the inter-relationship among multiple products of a firm that are
Internal Factors:
i. Organizational factors:
Overall price strategy is dealt with by top executives and the actual
mechanics of pricing are dealt with the lower levels in the firm.
shift in any one of the elements has an immediate effect on the otherthree.
iv. Costs:
Price are determined solely by costs in that the firm wishes to take its
However, in deciding the price of a new product, the firm should think
the market.
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v. Objectives:
External Factors
i. Demand:
The market of demand for a product or service obviously has a big impact
competitors.
ii. Competition:
Before a firm cam make pricing decisions. It must have a sense of not on
iii. Suppliers:
Suppliers of raw materials and other goods can have a significant effect on
iv. Buyers:
The various buyers that buy a firms products and service may have an
v. Economic conditions:
in most decision.
vi. Government:
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UNIT-V
The balance sheet provides the financial position of a company at any given point of time.
ii.balance sheet.
ii.liabilities.
i.fixed assets.
ii.investments.
iii.current assets.
v.miscallaneous expenditure
Their life period is very long, these are purchased for carrying out the operation in a company. Using this
the company can generating revenue.
6) What is investment?
The long term and short term financial securities owned by a company comes under this category. Here
lomg term investments means buying shares of the other companies.
Any asset that can be converted into cash within one year of time is called as current asset. They would be
converted into cash at the end of the operating cycle of a firm.
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i.cash.
ii.debtors.
iii.inventories.
It is the amont that a company loans to its employees, advances given to supplies, government contractors
and other agencies it is also include prepaid expenses.
i.share capital.
iii.secured loans.
iv.unsecured loans.
v.current liabilities.
It includes both equity share capital and preference share capital. Equity share holders are the owners of a
company they take risk and their dividend is not fixed but is case of preference share capital the dividend rate is
fixed.
It is nothing but the profit that is retained by accompany not by not paying it as dividend to the
shareholders.
i.revenue reserve.
ii.caapital reserve.
Loan amount borrowed by the firm by pledging assets (ie) securities are provided for these loans.
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This consists of amount that is to the suppliers when goods are purchased on a credit basis, advance
payments received accured expenses, provisions for tax.
The companies act does not any particular way in which the profit and loss account or the income
statement has to be prepared. This statement reflects the performance of a company over a period of time.
i.management.
iii.lenders
iv.suppliers.
v.customers.
vi.employees.
viii.others
A firm would enter into trouble if it spends more cash than it is able to generate. The firm should generate
adequate capital for it survival.
a. operating activities
b. investing activities
c. financing activities
It is one of the powerful tool for financial statement analysis. Ratio is nothing but the relationship between
two or more items.
a. past ratio
b. competitors ratio
c. industrial ratio
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d. projected ratio
The current financial years ratios can be compared with the previous years ratio to find whether the
financial position has improved over the years or not.
The ratio of a company can be compared with the ratio of the competitors and with the market leader.
The ratios of a firm can be compared with the ratios of the industry to which the particular firm belongs to.
1. What is balance sheet? State the uses and importance and draw the format of abalance sheet?
It is a statement of assets and liabilities of business as on a given date.
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Cashatbank Xxx
Closingstock Xxx
Prepaidexpenses Xxx
Operating ratio
Return on investment
Return of equity
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Activityratios:
Balancesheetratios:
Current ratio
Liquidity ratio
Proprietary ratio
Absolute liquidity
Window dressing
Personal bias
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Accounting is the art of recording, classifying and summarizing in a significant manner and in
terms of money, transactions and event which are in part at least of a financial character and interrupting the
results of there e of.,
Objectives of Accounting:
Input:
Recording
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Classifying
Summarizing
Analyzing
Interpreting
Output:
UNIT VI
1. What are the methods of capitial budgeting ? Traditional Methods Payback period Accounting
rate of return.(or) Average rate of return Discounted cash flow method. Internal rate of return Net present
value method.
2. What is meant by pay back method. Payback method is based on the period of investment
result, of an investment which can give the shortest duration of beneficiary that can be choosen by the
capital budgeting decision.
3. . What is meant by NPV? NPV means net present value of any investment.,It is the difference of
present value of the future cash inflows and the original investment.
4. Give the significance of capital budgeting? They involve substantial capital outlay They affect
the future of the business.
5. Write down the advantages and disadvantages of IRR method?
Advantages
Recognize time value of money
Disadvantages
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Capital budgeting is a difficult process to the investment of available funds. The benefit will attained
only in the near future but, the future is uncertain. However, the following steps followed for capital
budgeting, then the process may be easier are.
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Evaluation of Proposals
Fixing Property
Final Approval
Implementation
1.Identification of various investments proposals: The capital budgeting may have various
investment proposals. The proposal for the investment opportunities may be defined from the top
management or may be even from the lower rank. The heads of various department analyse the
various investment decisions, and will select proposals submitted to the planning committee of
competent authority.
2. Screening or matching the proposals: The planning committee will analyse the various proposals
and screenings. The selected proposals are considered with the available resources of the concern. Here
resources referred as the financial part of the proposal. This reduces the gap between the resources
and the investment cost.
3.Evaluation: After screening, the proposals are evaluated with the help of various methods, such as
pay back period proposal, net discovered present value method, accounting rate of return and risk
analysis.
4. Fixing property: After the evolution, the planning committee will predict which proposals will give
more profit or economic consideration. If the projects or proposals are not suitable for the concerns
financial condition, the projects are rejected without considering other nature of the proposals.
5.Final approval: The planning committee approves the final proposals, with the help of the
following:
(a) Profitability,
(b) Economic
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(c) Financial
6. Implementing: The competent authority spends the money and implements the proposals. While
implementing the proposals, assign responsibilities to the proposals, assign responsibilities for completing it,
within the time allotted and reduce the cost for this purpose. The network techniques used such as
PERT and CPM. It helps the management for monitoring and containing the implementation of the
proposals.
7. Performance review of feedback: The final stage of capital budgeting is actual results compared
with the standard results. The adverse or unfavourable results identified and removing the various
difficulties of the project. This is helpful for the future of the proposals.
This method represent the period in which total investment in permanent asset pays back itself. It measure
the period of time for the original cost of a project to be recovered from the additional earning of a project itself.
Investment are ranked according to the length of the payback period, investment with shorter payback
period is preferred.
Calculate annual net earnings(profit) before depreciation and after taxes, these are called annual cash
inflow
Divide the initial outlay(cost) of the project by the annual cash inflow, where the project generates constant
annual cash inflow
Payback period = cash outlay of the project or original cost of the asset
Annual cash inflows
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Where the annual cash inflows (profit before depreciation and after taxes) are unequal the payback period is found
by adding up the cash inflows until the total is equal to the initial cash outlay of the project.
Selection criterion
PPPI =
Merits
Demerits
It is a method rigid
It has completely discarded the principle of time value of money
It has not given any due weight age to cash inflows after the payback period
It has sidelined the profitability of the project.
2.4.2 Average Rate of Return method (ARR)
This method takes in to account the earnings expected from the investment over their whole life. It is
known as accounting rate of return.
The project which gives the higher rate of return is selected when compared to one with lower rate of
return.
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Merits
Under this method, the rate of return is calculated on the basis of profits extracted from the books but not on the
basis of cash inflows
The time value of money is not considered
It does not consider the life period of the project
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